When analyzing a hot stock market, investors must consider the bigger picture

By Dave Scranton

Advisors Academy

There’s a perception in the media, and therefore in the minds of many everyday investors, that the market is hot right now. And in one sense, they’re right — the S&P 500 index is up almost 25 percent since September. But — and this is the part most people miss — there is a bigger picture.

The S&P 500 hit its most recent low of 1,047 in late August of 2010. In late April of 2011, it was up to 1,363. By early August last year, it was down to 1,119, and, as I write this article, we’re flirting with 1,400.

There are two takeaways from this:

1. The difference between the high last April and the current level isn’t 25 percent, but between 3 percent and 4 percent.

2. We’ve all heard the Wall Street saying, “Sell in May and go away.” The idea is that it is common for the market to underperform in the summer months. Investors sell in late spring and get back in again come fall. In fact, that could be part of the reason the S&P 500 dropped almost 20 percent last summer.

To be honest, I don’t know if that’s going to happen again this year. What I do know is that a lot of media analysts look at that trend line and what they see are the peaks getting higher (1,400 is higher than 1,363, obviously) and the low spots moving up, and they announce that the trend line is moving upward. And at that scale, it’s true.

But on a bigger scale, you have to remember that the actual most recent peak of this secular bear market cycle was 1,565, reached in October, 2007, and that it was followed by a low of 676 just 15 months later on March 9, 2009. So while the trend line within this short-term cyclical cycle may, indeed, be moving upward, the lessons of stock market history suggest this is just part of the typical volatility that marks every long-term secular cycle, and may not last.

And keep this in mind: Even if the market does keep trending upward until gets back to that all-time high point from 2007, it would mark a 12 percent increase from where we are today. If, on the other hand, it should fall far enough to match the all-time low of this secular cycle, it would have taken a 50 percent drop. With a trade off like that, you have to ask yourself: Is it worth it?

The most important thing to remember, though, is that every secular bear market cycle throughout U.S. stock market history has lasted 15 to 20 years or more. If this one were to give way to the next long-term secular bull market after only 12 years, and without a third major drop (another common characteristic of secular bear cycles), it would be the first in history to do so.
Remember, too, that there are plenty of things happening in the world right now that could easily serve as the catalyst for that next big drop. The Eurozone crisis is heating up again as Spain’s economy deteriorates and its leaders and the EU work to head off full-fledged collapse — a situation even more complicated and fraught with global repercussions than the similar economic mess in Greece.

And there’s one more factor at play right now in the bigger market picture that is frequently overlooked. You know the old expression, “Once bitten, twice shy”? Well, for the baby boomer generation, it’s more like “Twice bitten, thrice shy.” That is, the median age of the boomers now is 57. They’ve been big stock market contributors for decades, but as they age, it seems likely they may want to reduce stock market exposure in favor of more conservative income generating options. Thus, demographics are also working against a historically speedy emergence from this secular bear cycle.

By the way, this may be part of the reason why government stimulus efforts aren’t really working as well as politicians had hoped. The reason the Fed is keeping short-term interest rates near zero and suppressing long-term rates through Operation Twist is they understand that when 401(k) portfolios are fatter and real estate values are higher, people feel better and are more apt to spend. But this time, the boomers aren’t taking the bait. They’ve been bitten twice now, so the low-interest rates provide no incentive to purchase a big house they have no business buying. In fact, one could argue that most have already purchased their dream homes and by now are ready to downsize.

So, if anything, these demographic realities are still further evidence that the market may get worse before it gets better. And in looking at the big picture, you have to at least ask yourself: is there any real evidence to suggest we’re going to see a historically quick recovery from this secular bear cycle? In my opinion, the answer is no.